Penalty clauses: Edgeworth Capital (Luxembourg) SARL and another v Ramblas Investments BV [2016] EWCA Civ 412

Is a fee that becomes payable on the default of a third party subject to the rule on penalty clauses?

The facts

Ramblas (the Borrower) entered into a suite of financing agreements to raise finance for the purchase of high value commercial real estate. One of the agreements was between the lender and two individual property investors and it contained a cross-default provision requiring payment of a substantial fee by the Borrower if that agreement was breached. The individual investors subsequently breached the agreement, triggering the fee of around €100 million. The Borrower argued (amongst other things) that the provision amounted to an unenforceable penalty.

The High Court held that the fee had been triggered and that the rule on penalties did not
apply because:

• the fee was not triggered by a breach of duty owed by the Borrower, but a duty owed by the individual investors
• the purpose of the fee was not as a deterrent against breach as it was triggered by other events (not just breach) and the fee had a “clear commercial justification” as a charge for providing a bridging loan.

The Borrower appealed.

The decision

The Court of Appeal upheld the High Court decision and rejected the Borrower’s arguments that the fee “far exceeded any loss that [the lender] could suffer as a result of the breach of contract”.

The Court of Appeal found that the fee had nothing to do with damages for breach of contract because there had been no breach by the Borrower, rather the fee was remuneration for providing the finance and was payable on a specified event. The Court of Appeal considered that the principles set out by the Supreme Court in Cavendish Square v El Makdessi and ParkingEye v Beavis [2015] UKSC 67 had been applied correctly.

Why is this important?

This case confirms that payment provisions that are not linked to the payor’s breach of contract will not be subject to the rule on penalties. The purpose of payment provisions and whether there is a commercial justification for them should be considered.

Any practical tips?

Draft contractual payment provisions carefully to provide for payment in circumstances other than breach and consider whether to included commercial justifications for the approach within
the provisions.