Penalty clause regarding IP rights harsh but not unenforceable

Permavent Ltd and another v Makin [2021] EWHC 467 (Ch)

The question

Were terms included in a settlement agreement preventing future challenges against IP rights unenforceable penalty clauses?

Key takeaway

The settlement agreement clauses were valid as they served and protected the Claimants’ legitimate business interests and the detriment to the Defendant, though harsh, was not disproportionate to make the clauses unenforceable as penalties.

The background

Steven Makin (Makin) and Timofei Yeremeyev (Yeremeyev) supplied products (mainly roofing) to the construction industry through a group of companies, including the Claimants, Permavent and Greenhill. Makin invented and patented roofing products under the name “Easy Roof System” and, in 2014, he granted a licence to Permavent to manufacture, use, sell and supply the Easy Roof System products.

In 2016, the relationship between Makin and Yeremeyev broke down and Makin left the business in 2017, purporting to terminate the patent licences and withdrawing permission for suppliers of certain Easy Roof System products to produce patented products.

Permavent brought a claim against Makin in July 2017 and sought (i) a declaration that Permavent owned the patents and patent applications (the IP Rights); and (ii) an injunction preventing Makin from transferring or licensing the IP Rights.

The parties subsequently entered into a settlement agreement under which Makin assigned the IP Rights to Greenhill. Additionally, in return for his agreement not to challenge the ownership/validity of or claim an entitlement to the IP Rights, Makin would be entitled to various payments (which would be forfeited/repayable in the event of a bre ach). Pursuant to those clauses, Permavent stopped making the payments when Makin sought to register an interest in the IP Rights.

Makin was found to be in breach by way of summary judgment so the issue before the Court was whether the clauses constituted an unenforceable penalty.

The decision

The Patents Court held that the relevant clauses were not unenforceable as penalties.

Referring to the Supreme Court decision in Cavendish Square Holding BV v Talal El Makdessi (Cavendish), the judge noted that whether an obligation amounted to a penalty depended on (i) whether legitimate business interests are served and protected, and (ii) whether the detriment imposed on Makin was extravagant, exorbitant, unconscionable or out of all proportion to that interest. The judge, Zacaroli J found in the Claimants’ favour.

The IP Rights were of vital importance to the business and any challenge could affect profitability through loss of sales and lead to reputational damage as it would damage the business’ ability to source, manufacture and sell products. Whilst the clauses were harsh on Makin, the detriment was not considered to be extravagant, exorbitant or unconscionable, nor was it disproportionate – a breach could cause significant harm to Permavent.

In reaching its decision, the Court also took into account other factors, in particular Makin’s aggressive and hostile behaviour in the period leading up to the agreement which demonstrated that he was likely to challenge the IP Rights and would maximise costs and the fact that he had entered the settlement agreement with the benefit of legal advice.

Why is this important?

This decision provides helpful guidance on the application of the Cavendish test on penalty clauses in a different context.

This decision also highlights the importance of the factual matrix as at the date of the agreement when assessing proportionality, considering the potential consequences of a breach at that time, as opposed to assessing the harm caused by an actual breach.

Any practical tips?

Consider whether the relevant provisions can be drafted as primary obligations that apply on a particular event or trigger (rather than a breach), so that the penalty rule is not even engaged. If the consequences do follow a breach, identify the legitimate interest(s) in question and the potential consequences/harm that may be suffered by a breach, and ensure that detriment (eg payments, loss of benefits, etc) are proportionate to those potential consequences. Ensure that the counterparty has taken legal advice (or at least had the opportunity to do so).