Cavendish Square Holdings BV & Anor v El Makdessi

The Claimants, Cavendish Square Holdings BV (“Cavendish”) and Team Y&R Holdings Hong Kong Ltd (“the Company”) are companies in the WPP group of companies, which is reputedly the world’s largest advertising and marketing communications group. The Defendant, Mr Makdessi, was the founder and owner, latterly with Mr Ghossoub (colloquially “Joe”), of what became by the late 1990s, and remained, the largest advertising and marketing communications group in the Middle East (“the Group”). The business of the Group was vested by 2008 in the Company, and Cavendish had acquired 12.6% of the Company. By an agreement dated 28February 2008 (“the Agreement”), Cavendish agreed to purchase from the Defendant and from Joe in the first instance 47.4% (so as to total 60%) of the shares in the Company, and provision was made for its subsequent purchase (by virtue of put and call options, to which I shall refer below) of the remaining 40%. These proceedings arise out of the (now admitted) breach of fiduciary duty by the Defendant which, if the relevant covenants in the Agreement are, as Cavendish asserts, valid and enforceable, would also constitute breaches of those covenants.

By the terms of the Agreement, and a Service Agreement which he signed contemporaneously, Joe agreed to remain as an employee and director of the Company, as he continues now to do. The Defendant, during the course of the negotiations leading up to the Agreement, made it clear that he did not wish to remain an employee, and what was intended to be a Service Agreement for him was replaced by an agreement also in the event simultaneously signed (“the Appointment”), by which he was appointed a non-executive director of the Company and non-executive chairman, for the initial term of eighteen months renewable, by which he agreed, in Clause 2.2 that “in addition to the requirements of all directors [his] role as a non-executive director has the following key elements”, namely identified specific obligations by way of ongoing support of the Company. The Appointment was specifically provided for in the Agreement (Schedules 9 and 12), as was Joe’s Service Agreement.

The consideration for the purchase by the Claimant of the 47.4% shareholding in the Company was very substantial. By Clause 3.1 of the Agreement Cavendish agreed to pay to the two Sellers, the Defendant and Joe (who were to share the consideration in the proportions 53.88% for the Defendant and 46.12% for Joe):

The price was justified in the Agreement itself as follows:

The Defendant resigned as non-executive chairman in April 2009, and on 1 July 2009, at the Company’s request, resigned as non-executive director of all companies, save the Company itself, from whose board he was removed on 27 April 2011, after the commencement of these proceedings.

What was discovered by the Claimants by December 2010 was that the Defendant had acted in breach of his duties to the Company as Director and, as Cavendish contends, thus also in breach of his obligations under Clause 11.2 of the Agreement. These proceedings were commenced on 15 December 2010, in which Cavendish sues for breach of the Agreement, and the Company for breach of fiduciary duty. The Defendant eventually admitted, only as recently as October 2012, when with my consent his Amended Defence and Counterclaim was reamended, that he was in breach of duty to the Company. Very substantial allegations had been pleaded, and were to be the subject of evidence, in respect of the Defendant’s alleged breaches. The Defendant admitted (without accepting all such factual assertions by the Claimants) that he had in fact (in breach of the Carat Clause) continued to be involved and interested in Carat. A Part 36 offer was made by the Defendant to the Company in respect of the Company’s claim for breach of fiduciary duty in the sum of $500,000, and was accepted by the Claimant on 8 October 2012. The proceedings have continued in respect of the Claimant’s claim for breach of the Agreement (together with certain other matters relating to dividends, which are not before me at this stage).

As a result of this slimming down of the case, to avoid any need for proof of the alleged breaches at this stage, the issues before me have been effectively ones of law in relation to the effect of the Agreement, and have been ably and effectively argued by counsel, Joanna Smith QC and Richard Leiper for Cavendish and Michael Bloch QC and Camilla Bingham for the Defendant. Apart from the provisions of the Agreement which I have set out in paragraphs 3 and 4 above, the other material clauses (again incorporating the definitions where appropriate) are now set out:

Cavendish claims that the Defendant is in any event, by virtue of his admissions of breach of fiduciary duty, in breach of clause 11.2 in relation to (at least) his continued involvement in Carat, and seeks a declaration that the Defendant is a Defaulting Shareholder, is not entitled to payments of the Interim Payment or the Final Payment as a result of Clause 5.1, and is obliged, as of the date 30 days after the service of a Notice by it pursuant to Clause 5.6, namely 14 January 2011, to sell to Cavendish all his shares in the Company at the Defaulting Shareholder Option Price, and it seeks specific performance of the latter obligation. Cavendish did seek damages for the breach of the Agreement, but in the light of the Defendant’s response that all its pleaded case (in paragraph 31 of the Reamended Particulars of Claim) was by reference to the loss of value in its shareholding in the Company by virtue of the Company’s losses included in paragraph 30 of the same pleading, and that such was irrecoverable as “reflective” (or, as I prefer, derivative) loss, (irrecoverable as a result of the decision of the Court of Appeal in Prudential Assurance Co. Ltd v Newman Industries Ltd (No. 2) [1982] Ch 204 and in the House of Lords in Johnson v Gore Wood and Co. [2002] 2 AC 1), it no longer pursues such claim for damages in these proceedings. The Company’s claim for damages has of course been compromised as set out in paragraph 6 above.

The Defendants’ case is as follows, all upon the basis that if its submissions in law fail then it accepts that it has no defence on the facts:

It is common ground between the parties that, both for the purpose of resolving the reasonableness of the covenant, and the commercial justifiability and otherwise propriety of the alleged penalty clause(s), the factual matrix is admissible in that regard: see in particular as to restraint of trade Haynes v Doman [1899] 2 Ch 13 at 24, Bridge v Deacons [1984] 1 AC 705 at 714 and Dawnay Day & Co v De Braconier d’Alphen [1998] ICR 1068 at 1075, 1086 – 1087 (Walker J) and 1100 D-H (CA) and as to the law of penalties Lombank Ltd v Excell [1964] 1 QB 415 (CA) at 427 and Murray v Leisureplay Plc [2005] IRLR 946 (CA) at paras 52, 106.

The Claimant served witness statements from a number of witnesses which it was intended to call, but in the event, and as a result of the admissions by the Defendant, the evidence of only two witnesses was to be adduced, and since the Defendant chose not to require them to be called for cross examination, their evidence was read, namely the evidence of Mr Andrew Scott, WPP’s Director of Corporate Development since 1999, who led the commercial team that negotiated with the Defendant and Joe in relation to the acquisition, and the first 24 paragraphs of a witness statement by Joe, who was of course party with the Defendant to those negotiations, and remained as Chief Executive Officer of the Group after the acquisition.

There is, in relation to the issue of penalty, dispute by Mr Bloch as to the effect of some parts of the (thus unchallenged) evidence of Mr Scott, to which I return below, but, that apart, I summarise the effect of the factual matrix evidence:

There is again no issue between the parties as to the fact that the drafts were amended as between the respective solicitors (after detailed communication with their clients) in the course of negotiations, and the following in particular is clear:

The significant impact of all this, the detail of which does not in effect matter, is in my judgment as follows:

Counsel for the parties very helpfully agreed a list of Propositions of law with regard to restraint of trade, which I set out below and happily accept, subject to a few additions I make by reference to non-controversial submissions made to me, and to the 32 authorities to which I was referred.

The onus is on the Claimant to establish the reasonableness of the restraints (proposition (i) above). This is a vendor-purchaser covenant, in relation to which (see proposition (vi)) such onus is not a heavy one. As appears from the recitation in Clause 11.1 of the Agreement (paragraph 4(i) above) and the evidence summarised in paragraph 12 above, there was substantial goodwill in the business, for which Cavendish paid substantial monies – see Alec Lobb (supra). Cavendish in essence, as Ms Smith put it in oral argument, was ‘buying a clear run’, as it was entitled to do.

The Defendant did not criticise any particular aspect of the restrictions (save as to duration, to which I shall refer below). There was no challenge to the width of the Prohibited Area (save in one respect, called the ‘Yemen point’ in argument, which Mr Bloch in the event did not pursue), to the Restricted Activities or to the definition of Client. Mr Bloch referred to what he called an “elision of threats”, suggesting that there was no sufficient consideration of the need for the separate covenants, but it seems to me clear that there was simply an effective protection of the goodwill (including customers and workforce) against competition by the founder of the business which Cavendish was purchasing who would be a formidable competitor, and who specifically agreed by Clause 7.5 to terminate his contract with Carat (and did not).

There were inevitably references by Mr Bloch to the discussions referred to in paragraph 13(i) above during negotiations, which resulted in any breach of Clause 11.2 being left as a triggering breach without an express requirement for it to be material. However, not only is it clear that (as there described) this was fully negotiated ‘on a level playing field’ as between experienced lawyers for vendor and purchaser (not employer/employee), but I am satisfied that it was entirely reasonable for the purchaser to take the view, and for this court to conclude, that any ‘competition breach’ was material. Various metaphors were used in argument, mostly by me – the ‘big beast on the prowl’ or the ‘wolf among the folds’ – but it is clear to me that the Claimants were entitled to be concerned that they required protection from any competition by the Defendant, in any of the respects set out in Clause 11.2.

The interest which was protected was against competition by a very influential vendor, but in addition one who was continuing as a non-executive chairman/director of the Company (with additional obligations under the Appointment), and, even after the expiry of the Appointment, as director and minority shareholder. The Claimant was in my judgment entitled to the deferred restraint referred to in Proposition (ii). Mr Bloch submitted that the provision for the restraint was uncertain, because the date of its commencement or duration was uncertain, thus rendering the covenant unreasonable. I do not accept this. While he remained a director, he would in any event owe similar fiduciary duties. Its real significance would be in effect at some stage in the future when he would cease first to be a director and then to be a minority shareholder, but any such covenant in an employment contract or a partnership agreement (e.g. Bridge v Deacons) will only become significant once the covenantor leaves the employment or partnership at a date in the future. The deferredrestraint in this case was clear, certain and required.

As to the duration of the covenant, it is explained by Mr Bloch to be one for a minimum of eight and a half years. This is because (absent an earlier breach and operation of Clause 5.6) the call option under Clause 15 can only be operated by the Defendant (at the earliest) between January and March 2011, whereafter there then follows the period for calculation of the relevant OPAT for the next two years (see paragraph 7(vi)(c) above), and then two years. The Defendant thus had the freedom to relieve himself of the covenant, and be free to compete, by exercising the call option, but he would have to wait to be free until summer 2016. Mr Bloch submits that this was far too long. He referred to the advice of the Office of Fair Trading as in some way indicative, but I found this analogy unhelpful, not only because such (non-binding) advice does not apply to an international merger, but because it certainly has no application to the facts of this case.

There was some discussion, raised by me, as to the possible use of a blue pencil in respect of the definition of Relevant Date, which I have incorporated into my recitation of Clause 11.2 in paragraph 4(ii) above and now repeat:

“Relevant Date means in respect of a Seller the later of the date of termination of his employment by the Group, the date that he no longer holds any Shares or the date of payment of the final instalment of the Option Price pursuant to Clause 15.5(b).”

The first of the three dates is of no relevance to the Defendant, as I have already stated, and I raised the question as to whether the third limb could be severed, so as to leave only “the date that he no longer holds any Shares”, as being the Relevant Date (see Attwood v Lamont (supra) at 577).

Mr Bloch further pointed out that the restrictive covenant imposed on Cavendish, restraining competition with its business by other members of the WPP Group in Clause 11.7, lasted only for some four years, until after the calculation of the Final Payment.

I am satisfied that there is no substance in Mr Bloch’s contentions:

I am satisfied that the provisions of Clause 11.2 are not in unreasonable restraint of trade.

Clauses 5.1 and 5.6, set out in paragraph 7 above, are submitted by the Defendant to constitute, both severally and, a fortiori, together, a penalty. As with the restraint of trade arguments, counsel have put together a bible of the relevant authorities on this topic, 28 of them. The starting point was the seminal speech of Lord Dunedin in Dunlop Pneumatic Tyre Co. Ltd v New Garage and Motor Co. Ltd [1915] AC 79, for which he had had a dry run in delivering the judgment of the Privy Council in Public Works Commissioner v Hill [1906] AC 368. There were three other speeches of their Lordships in the House of Lords, and, as they were unanimous, to an extent their speeches must be drawn on in order to flesh out the conclusions of Lord Dunedin. I set them out as follows, as further occasionally clarified by subsequent judicial authority:

In Colman J’s judgment in Lordsvale, to which I have referred above, he encapsulated the modern approach to penalties, some eighty years on from Lord Dunedin, not only by reference to the modernisation of the language. In a passage which was subsequently approved by the Court of Appeal in both Cine Bes per Mance LJ at para 15 and in Murray, he made it clear that the analysis of whether a provision was or was not a penalty no longer depended upon the dichotomy between a liquidated damages clause and a penalty and upon the need to concentrate upon whether there was a genuine pre-estimate of loss in order to resolve such dichotomy. He said this (763G-764A):

“It is perfectly true that forupwards of a century the courts have been at pains to define penalties by means of distinguishing them for liquidated damages clauses. The question that has always had to be addressed is therefore whether the alleged penalty clause can pass muster as a genuine pre-estimate of loss. That is because the payment of liquidated damages is the most prevalent purpose for which an additional payment on breach might be required under a contract. However, the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach.”

Mance LJ said at para 15 in Cine Bes:

“I have…found valuable Colman J’s further observations in Lordsvale…which indicate that a dichotomy between a genuine pre-estimate of damages and a penalty does not necessarily cover all the possibilities. There are clauses which may operate on breach, but which fall into neither category, and they may be commercially perfectly justifiable.”

This concentration on commercial justification becomes the more significant as the law has developed, as will be seen, so as to apply the concept of penalty in a wider context. Thus I concluded in M&J Polymers Ltd v Imerys Minerals Ltd [2008] 1 AER (Comm) 893 that a ‘take or pay clause’ might qualify as a penalty clause, i.e. that the concept of penalty could apply to a debt claim as much as to a damages claim (contrary to the previous understanding in Jervis v Harris [1996] Ch 195). My conclusion (at paragraph 46) was that the clauses in question plainly had commercial justification and (as I summarise in paragraph 25 of my later judgment in E-Nik Ltd v Department for Communities and Local Government [2012] EWHC 3027 (Comm)) “did not amount to oppression, were negotiated and freely entered into between parties of comparable bargaining power and did not amount to a provision in terrorem” (see also Lancore Services Ltd v Barclays Bank Plc [2008] EWHC 1264 (Ch) [2008] 1 CLC 1039 at para 98 per HHJ Hodge QC).

Quite apart from the fact that the onus of establishing that a provision is an unenforceable penalty lies upon the party so asserting, there is substantial authority as to the reluctance of the court so to conclude; a reluctance of a substantially greater variety than the ‘judicial deference’ to which I have referred in the case of restraint of trade at paragraph 15(vii) above. Diplock LJ in Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 (CA) at 1447 stated that “the court should not be astute to descry a “penalty clause” in every provision of a contract which stipulates a sum to be payable by one party to another in the event of a breach of the former”. Lord Woolf in Philips at 58 agreed with Diplock LJ, and approved the view of Dickson J in the Supreme Court of Canada in Elsley v JG Collins Insurance Agencies Ltd [1978] 83 DLR 1 at 15 (itself approved by the Australian High Court in Esanda Finance Corporation Ltd v Plessnig [1989] ALJ 238) that:

“It is now evident that the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no place where there is no oppression.”

In expressing his agreement, Lord Woolf referred to the fact that “it will normally be insufficient to establish that a provision is objectionably penal”. Similarly Jackson LJ in Alfred McAlpine Projects v Tilebox [2005] EWHC 281 (TCC) 104 Con LR 39, at paragraph 48, noting that he had only seen four reported cases where a clause has been struck down as a penalty, stated that “because the rule about penalties is an anomaly within the law of contract, the courts are predisposed, where possible, to uphold contractual terms which fix the level of damages for breach. This predisposition is even stronger in the case of commercial contracts freely entered into between parties of comparable bargaining powers”. Lewison J similarly stated in Meretz Investments NV v ACP Ltd [2007] Ch 197 at para 349 that “to characterise a clause as a penalty, with the consequence that the court will refuse to enforce it, is a blatant interference with freedom of contract, and should normally be reserved for cases of oppression”.

I have referred in paragraph 27 above to the way in which in more modern times the concept of penalty, while remaining a rara avis, has, at least in principle, moved outside the original province of a clause providing for an extravagant assessment of (liquidated) damages. One development, to which I have referred, was to expand its operation, although in the event unsuccessfully, into what was otherwise a claim in debt. Another is so as to apply the concept to a contractual agreement for the transfer of property, as (although again unsuccessfully on the facts) in Else (1982) Ltd v Parkland Holdings Ltd [1994] 1 BCLC 130, where Evans LJ stated (at page 137) that “the common law rule against penalties can operate against a clause which provides for the transfer of property or other monies worth as distinct from the payment of money itself”. However the most relevant extension for the purposes of this case (and in particular by reference to Clause 5.1) is the extension of the doctrine of penalty to embrace not only a provision for the payment or transfer of money (or property), but a provision which on its face entitles the innocent party to withhold monies which it otherwise would be required to pay over. The courts have strayed into an area previously thought to be occupied only by the doctrine of forfeiture, thus “penal forfeiture”.

This question was addressed in general terms in the Court of Appeal in The Fanti [1989] 1 Lloyds Rep 239, a case in which judgment was delivered on 16 July 1988. As happened more frequently in those days before the easy availability of recent and unreported cases electronically, another Court of Appeal decision, in Jobson v Johnson [1989] 1 WLR 1026, in which judgment was delivered on 25 May 1988 (to which I shall refer below) does not appear to have been cited. In The Fanti, Saville J at first instance had found that the clause in question was not a penalty clause because it did not require the contract breaker to pay money in the event of breach, but simply deprived the contract breaker of an entitlement to receive monies: he concluded that it was at best a forfeiture clause, in respect of which in some cases a party in default had an equitable right to seek relief against forfeiture. In the Court of Appeal, reliance was placed upon the decision of the House of Lords in Gilbert Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689, in which a clause disentitling a set-off was regarded by four of their Lordships (Lords Reid, Morris of Borth-y-Gest and Salmon, and Viscount Dilhorne) as penal, or a penalty or “a heavy penalising provision”. Bingham LJ, in the minority in the Court of Appeal in The Fanti interpreted the remarks of their Lordships in Gilbert Ash as obiter, since they related to a clause which in the event was not determinative of the issue, and he agreed with Saville J. He concluded that the provision was not a penalty clause, distinguishing it from forfeiture, and the need for the contract-breaker to seek relief, which would be unlikely to be granted in a commercial contract, and in any event had not been sought. Stuart Smith LJ, with whom O’Connor LJ agreed, thus forming the majority, was persuaded that the views of their Lordships in Gilbert Ash did “form part of the decision” but (at 262) in any event concluded that “in principle I can see no distinction between withholding or disentitling a person to a sum of money which is due to him and requiring him to pay a sum of money” and saw “no authority for the proposition that a forfeiture clause may not also be a penalty, if it has the necessary characteristics”.

In the earlier Court of Appeal decision in ECGD v Universal Oil [1983] 1 Lloyds Law Rep 448, in which Gilbert Ash was cited (but again Jobson does not appear to have been) Waller LJ expressed - although obiter, because the clause was found not to be a penalty on the facts - a similar view to that of Stuart Smith LJ (though again it was not cited in TheFanti) that:

“If the effect of a provision in a contract between A and B is to entitle B to receive sums at the expense of A in the event of non-performance by A of one or more of his obligations under that contract, and those sums are not a genuine pre-estimate of the damage which is likely to be suffered by B in the event of such breach, then the proviso must, I think, prima face fall within the penalty area; it cannot make any difference whether B is to receive such sums by way of direct payment by A or by way of retention at A’s expense.”

In The General Trading Company (Holdings) Ltd v Richmond Corporation Ltd [2008] EWHC 1479 (Comm) Beatson J specifically addressed The Fanti (having been referred to Gilbert Ash and to Jobson, and another case, to which I shall refer, Workers Trust & Merchant Bank Ltd v Dojap Investments Ltd [1993] AC 573, but not to ECGD) and he said (at 113):

“The penalty rule has been seen to have application beyond the paradigm situation of a provision that requires the payment of a sum of money in the event of breach. It has been held to apply to a clause entitling the innocent party to the retransfer of the property which had previously been transferred to the contract breaker (Jobson...) and (see Workers Trust...) to a clause which requires a contract breaker to forfeit a deposit or sum of money due or to become due to the other party in the event of breach. ...Whatever the position may be in a higher court, the decision in The Fanti... that a clause entitling the innocent party to a breach of contract by the other party to withhold a payment otherwise due is subject to the penalty rule binds me.”

Ms Smith accepts that I, like Beatson J, am bound by the Court of Appeal decision in The Fanti, by the majority decision of Stuart Smith and O’Conner LJ, rather than the minority view of Bingham LJ and the first instance decision of Saville J. However she points out and Mr Bloch accepts, two very significant factors arising from the apparent conclusion that the concept of penalty can be applied seamlessly to a situation of forfeiture:

It is certainly right that these matters were not considered by the majority of the Court of Appeal in The Fanti, but it is at this stage that, under Mr Bloch’s guidance, I turn to consider Jobson, a decision of the Court of Appeal in which the leading judgments were given by those masters of the law of equity Dillon and Nicholls LJ, with whom, save as to remedy, Kerr LJ agreed. The clause in that case provided that, in default of payment of any instalment (on a share purchase) the defendant was obliged to transfer shares at a fixed price. There was a counterclaim for relief, which was struck out for non-compliance with court orders. The plaintiff had submitted at first instance that the clause was a penalty clause (which in the event the first instance judge found that it was) but that it created a binding obligation which the courts would enforce unless equitable relief were granted, which was not available because the counterclaim for relief had been struck out. The Defendant submitted that, notwithstanding the absence of the counterclaim for relief, the penalty clause could not be enforced. Both of the majority judgments recognised that (per Dillon LJ at 109B) “the appeal raises a narrow point of considerable difficulty, which only arises because of the unusual course these proceedings have taken”, and (per Nicholls LJ at 1038B–C) because the unusual circumstances had “made it necessary to grapple with problems concerning the effect of an admittedly ‘penal’ provision in a case where there is no extent application for relief from ‘forfeiture’”. There was no appeal against the Judge’s finding that the clause was a penalty clause, but in any event the Court reached a similar conclusion to that in The Fanti as to the fact that a penalty clause is not restricted to a provision requiring the payment of money as if it were liquidated damages. Dillon LJ said at 1034H:

“Does it make any difference then, that the penalty in the present case is not a sum of money? In principle, a transaction must be just as objectionable and unconscionable in the eyes of equity if it requires a transfer of property by way of penalty on a default in paying money as if it requires a payment of an extra, or excessive, sum of money… There should be no distinction in principle between a clause which requires the defaulter, on making default in paying money, to transfer shares for no consideration, and a clause which in right circumstances requires the defaulter to sell shares to the creditor at an undervalue. In each case, the clause ought to be unenforceable in equity in so far as it is a penalty clause.”

Dillon LJ extracted the principle from Lord Dunedin’s earlier judgment in Public Works Commissioner v Hills “thata clause identified by the courts as a penalty clause cannot be enforced so as to enable a party to recover or retain more than his actual loss.” He concluded (at 1037A) that it was not open to the court to “decree specific performance of the sale of the shares to the plaintiff, but at a higher price than the £40,000, so as to recoup to the defendant what he has actually paid for the shares, since that would involve the court making a new contract between the parties.” He concluded however (at 1037F) that “by analogy to the power which the court has had for a very long time to direct an enquiry as to damages in a penalty case so as to ensure there was no enforcement beyond the plaintiffs actual loss”, alternative remedies could be offered to the innocent party, “but they cannot be forced on him. If neither is acceptable to him the appeal must, in my judgment, be allowed and the order for specific performance must be discharged, since otherwise the court would be lending its machinery to the enforcement of the penal effects of a clause which has been clearly identified as a penalty clause. But in that event...the plaintiff will be free to bring a fresh action for payment.”

Nicholls LJ founded his judgment (at 1039H) on the fact that “today, when law and equity are administered concurrently in the same courts, and the rules of equity prevail whenever there is any conflict or variance between the rules of equity and the rules of the common law with reference to the same matter…, a penalty clause in a contract is, in practice, a dead letter. An obligation to make a money payment stipulated in terrorem will not be enforced beyond the sum which represents the actual loss of the party seeking payment ...or... beyond a sum recoverable as damages for breach of... obligation. (For convenience I shall hereafter refer to that sum as “the actual loss of the innocent party)… Although in practice a penalty clause... is effectively a dead letter, it is important... to note that... the strict legal position is not that such a clause is simply struck out of the contract, as though with a blue pencil, so that the contract takes effect as if it had never been included therein. Strictly the legal position is that the clause remains in the contract and can be sued upon, but it will not be enforced by the court beyond the sum which represents, in the events which have happened, the actual loss of the party seeking payment.”

He continued at 1041E as follows:

“Accordingly, once a court becomes awarethat the amount claimed by the plaintiff is a penalty arising on default of payment of a specific sum of money, the legal consequence which follows, as day follows night, is that the amount claimed will be scaled down by the court to a sum equal to the unpaid principal, with interest and costs. That consequence, albeit having its historical origin in equity, is not dependent upon the court exercising a discretion to grant or withhold relief having regard to all the circumstances. It is a consequence which for many years has followed automatically, regardless of the circumstances of the default.

In this respect, as the law has developed, a distinction has arisen between the enforcement of penalty clauses in contracts and the enforcement of forfeiture clauses. A penalty clause will not be enforced beyond the sum which equals the actual loss of the innocent party. A forfeiture clause, of which a right of re-entry under a lease on non-payment of rent is the classic example, may also be penal in its effect. Such a clause frequently subjects the defaulting party in the event of non-payment of rent or breach of some other obligation, to a sanction which damnifies the defaulting party, and benefits the other party, to an extent far greater than the actual loss of the innocent party. For instance, the lease may be exceedingly valuable and the amount of unpaid rent may be small. But in such a case the court will lend its aid in the enforcement of the forfeiture, by making an order for possession, subject to any relief which in its discretion the court may grant to the party in default. Normally the granting of such relief is made conditional upon the payment of the rent with interest and costs. If that condition is not complied with, and subject to any further application by the tenant or other person in default for yet more time, the forfeiture provision will be enforced. Thus the innocent party is in a better position when seeking to enforce a forfeiture clause than when seeking to enforce a penalty clause in a contract.

This is not the occasion to attempt to rationalise the distinction. One possible explanation is that the distinction is rooted in the different forms which the relief takes. In the case of a penalty clause in a contract, equity relieves by cutting down the extent to which the contractual obligation is enforceable: the “scaling down” exercise, as I have described it. In the case of forfeiture clauses equitable relief takes the form of relieving wholly against the contractual forfeiture provision, subject to compliance with conditions imposed by the court. Be that as it may, I see no reason why the court’s ability to grant discretionary relief automatically granted in respect of a penalty clause if, exceptionally, a contractual provision has characteristics which enable a defendant to pray in aid both heads of relief.”

He emphasised, as had Dillon LJ, that the Court could not make a new bargain for the parties, and referred to the difficulty of “scaling down” an obligation to transfer shares, but otherwise concluded that there could be no difference between an obligation to pay a stipulated sum of money arising on a default and an obligation to transfer specified property arising on a default. He agreed with the proposal of Dillon LJ to offer two alternatives to the innocent party for him to take up, if desired, both of which would involve sale or valuation of the shares (it is apparent that the shares were in fact seen as the only source whereby the debt to the innocent party could be satisfied.)

The following propositions appear to me to arise as a result:

Jobson accordingly recognises in terms (especially per Nicholls LJ at 1039H) that equity has a role in relation to penalty clauses, and that the jurisdiction of the court is not limited either to enforcing on the one hand, or not enforcing on the other hand, the offending clause. In this case the Defendant has not sought relief, indeed not seeking permission to amend to do so even when the point was raised in argument. The court in Jobson was in a position to offer remedies to the plaintiff, which he could choose whether to accept, whose purpose was to enforce if so advised the effect of the penalty clause to a non-penal extent. I have referred in paragraph 32 above to Workers Trust & Merchant Bank Ltd, a decision of the Privy Council. This adds nothing, save for the reference by Lord Browne–Wilkinson, another expert in equity, to the fact (at 582D) that there is “clear authority that in the case of a sum paid to one party by another under the contract for security for the performance of that contract, a provision for its forfeiture in the event of non-performance is a penalty from which the court will give relief”.

It is thus plain that the two concerns expressed in paragraph 33 above as to the impact of treating what is in fact a forfeiture as a penalty clause, not addressed in The Fanti, can in fact be addressed by reference to Jobson, and to a reconciliation of the authorities namely:

I turn to consider the two impugned clauses in this case, Clause 5.6 and 5.1, in their contractual context, but also in the factual context set out in paragraph 12 and 13 above.

Both the clauses come into effect when, but only when, the Defendant is a Defaulting Shareholder, i.e. they deal with the consequences of Clause 11.2, which I have found not be in unreasonable restraint of trade. I have already decided that Cavendish was entitled to conclude (and after negotiations the parties agreed) that competition breach by this Defendant – even one where an initial solicitation might be, if it was, (and if it was discovered) unsuccessful, – would signify that the “wolf was in the fold” and be material. I am also satisfied that breaches of all or any of the sub-clauses of 11.2 would be such that (per Lord Parker) “the damage likely to accrue from each stipulation [would be] the same in kind”. The issue nevertheless is whether the consequences are penal.

Clause 5.6 is submitted by Ms Smith not to be a candidate for a penalty clause at all. It certainly has nothing to do with being a “pre-estimate of damage”, but the ambit of the doctrine of penalty has, as discussed in the paragraphs above, so mutated that this no longer seems to me to be a requirement. The dispute is whether:

It seems to me clear, and Mr Bloch did not vigorously contest this point, that it was manifestly sensible for the parties to agree for there to be a provision for ‘decoupling’ a defaulting shareholder from Cavendish in the event of a breach. The put option did not arise for a considerable period, and the breach might – as indeed was the case – arise very early in the relationship, and it is obvious that the parties could not be left together, and that in particular the defaulter should not remain a minority shareholder. The issue relates to the valuation of the shares. It is of course plainly not anything like the same as the position in Jobson, where the £40,000 was fixed whatever the value of the shares or the timing of the transfer.

Mr Bloch submits that the price fixed by the operation of Clause 5.1 for the purchase of the Defendant’s proportion of the remaining 20% shareholding is an unfair undervalue, and that the clause is a penalty. His argument has two main thrusts.

The first is the evidence of Mr Scott on behalf of the Claimant, to which I shall refer. But before doing so I must set this in context:

Mr Scott’s witness statement stated (at paragraph 37) that a Defaulting Shareholder “undermines the very thing that he is selling. He agrees that in such an event, he will receive a lower price for the purchase of his interest, as the Defaulting Shareholder price is calculated on the basis of the net asset value at the date of breach – i.e. a price which does not take into account any goodwill of the company”. Mr Bloch submitted that this shows that there was an intention to achieve a lower price, by excluding from the valuation goodwill, an essential and valuable ingredient of it (see, as to the calculation of the original consideration, paragraphs 4(i) and 14(ii) above). The Defendant was thus required to sell at an undervalue, and Mr Scott thus admits this.

Mr Bloch also points out the different calculation of the value of the shares from that in Clause 15 which would result from the exercise of the put option by the Defendant, based upon multiples of the average OPAT, as set out in paragraph 7(vii) above: there is a cap of $75million. He recognises that this is a different kind of valuation, and one which is at the option of the Defendant, but he still points to the inevitable difference between a valuation based only on NAV and one which will be based upon a multiple of years’ profits. This he submits is intended as a penal consequence to deter breach.

Ms Smith submits that there is no question of the provision, or the valuation, constituting a penalty. She submits as follows:

I am not persuaded that Clause 5.6 is a penalty clause, the onus being upon the Defendant:

I turn to Clause 5.1. Mr Bloch submits that this clause cannot possibly be a genuine pre-estimate of loss. The only loss that could flow, at any rate during the period while the Defendant remained a director (which he was entitled to do while he remained a minority shareholder) would be derivative loss (see paragraph 8 above): i.e. loss suffered by Cavendish through the damage to its shareholding in the Company, which the Company would be entitled to recover (and in the event it has accepted the Part 36 offer in these proceedings, as appears in paragraph 6 above), and hence Cavendish could not. Any other loss is not simply difficult to prove (the fifth proposition in paragraph 25 above) but to identify. Ms Smith submits that if the clause has to be regarded as a genuine pre-estimate of loss, the loss in question is the substantial damage to the value of its investment in the Company, even if it were irrecoverable as a result of the decision in Prudential – indeed, all the more reason to cover it by an express provision if it cannot be recovered by a claim for damages: I threw out the question as to whether a loss that was otherwise statute-barred might be a similar analogy. There is however no authority for the proposition that a clause said, in order not to be a penalty, to amount to a genuine pre-estimate of loss can be justifiable as a genuine pre-estimate of irrecoverable loss. Diplock LJ in Robophone Facilities at 1446H referred to “a sum greater than the measure of damages to which he would be entitled in common law”, which suggests that the loss must be recoverable; but some comfort could be gained by the words of Lord Dunedin himself in Public Works Commissioner v Hills at 375, when he speaks of a “genuine pre-estimate of the creditor’s probable or possible interest in the due performance of the principal obligation”.

However, the reality is that, in the modern approach to the concept of penalty discussed above, there is no longer the need for the dichotomy between liquidated damages and genuine pre-estimate of loss, and so the relevant questions seem to me to be simply:-

Ms Smith submits that there is a plain commercial justification. This is to adjust the consideration. Cavendish agreed to pay a very substantial sum for goodwill. The NAV (including undistributed profits for the year) as per schedule 11 (see paragraph 14(ii) above) was $69, 744, 340, and for 47.4% of the Company Cavendish were paying (by the first and second payments) $63.5million, and then up to a cap of a further $82million. In the event of a competition breach – and particularly continued competition by the Defendant with Carat in breach of the Carat Clause – the consideration would be adjusted by cancellation of the last two payments, and that is what the parties agreed.

Mr Bloch refers to the evidence of Mr Scott in paragraphs 38-40. This reads as follows:

“38.

The provisions set clear restrictions on each Seller, explaining the type of behaviour which is absolutely prohibited and cannot be tolerated given WPP’s very significant investment in the Group. [The Defendant] and Joe had of course also received substantial sums of money under the transaction, so restrictions of this nature are to be expected.

39.

As I have explained above, provisions like these are negotiated and included in the contractual framework for every WPP acquisition as WPP must have a mechanism for protecting the investment it makes in any given business. This was particularly the case in this instance given the influence and standing of [the Defendant] and Joe within the Middle East advertising community. They were both figureheads for the THG Group and were key to the success of the business historically. It was therefore critical for WPP that it sought to ensure that they continued to support the business or, at the very least, not to act against its interests. It did so by including the terms I have referred to above.

40.

I recall that the remedy was fully and specifically negotiated and agreed with Lewis Silkin, the lawyers for [the Defendant] and Joe, at the time in relation to the terms of clause 11.2, the definition of Defaulting Shareholder and, in the case of Joe, the restrictive covenants contained in his service agreement. ”

Mr Bloch submits that:

Ms Smith submits as follows:

I do not regard un-cross-examined witness statements as statutes or documents to be construed, and ambiguities if any to be resolved. I am not prepared to carry out the exercise which Mr Bloch invites. If I have to do so, I prefer the interpretation of Ms Smith.

I am satisfied that there was a commercial purpose, such as is asserted by Ms Smith, and the existence of detailed negotiations by experienced solicitors seems to me to negative oppression. The juxtaposition on the one hand of substantial delayed payment for goodwill and on the other hand a series of covenants which is intended to safeguard and protect that goodwill is of particular significance in this case. I also note as of importance that, because of the staged payments, if the breach only occurs, or is discovered, after the payment of the Interim Payment, then it will only be the Final Payment which will become irrecoverable. That suggests that, as is good sense, the earlier the default, the more damaging it is likely to be, and the more it detracts from the goodwill that was purchased; so that it is thus in those circumstances (which have in fact occurred) that the earlier Interim Payment also does not fall to be paid.

If Clause 5.1 stood on its own, I do not conclude that it would be an extravagant consequence of the default, or such as to render the purpose uncommercial or suggest that, because of any such extravagance, the intention must be to deter. I now consider it together with Clause 5.6. Taking the two clauses together does not alter my conclusion:

However I must next filter in the fact that the genuine pre-estimate of irrecoverable loss or the adjusted consideration was on the basis of substantial loss of goodwill by reference to damage to Cavendish’s shareholding in the Company. Yet not only is there no express provision in the Agreement that in the event of operation of the Defaulting Shareholder provisions the Company will not pursue the Defendant for damages in addition, but, in the event, by virtue of the Company’s acceptance of the Part 36 offer, such damages have been paid and received, and have thereby compensated the Company and reduced the loss to the Claimant’s shareholding. The payment accepted was in the sum of $500,000, but I take into account and understand the obvious explanation by Ms Smith that this figure was accepted for litigation reasons against a difficulty, if not impossibility, of proving (coupled with a reluctance to seek to prove) customer connection loss. Nevertheless that sum has been paid over and accepted, and Cavendish in addition relies upon Clause 5.1. I invited Mr Bloch to consider whether he wished to assert that this constituted some kind of election, but after overnight thought, he did not do so.

I consider that this is ‘double counting’, and that, when taken together with Clause 5.1, it renders that clause a penalty, resulting in Cavendish receiving an extravagant return, by way of more than its conceivable or possible loss of value in the shareholding and more than an appropriate adjustment to consideration. I am armed with the benefit of the jurisdiction and discretion which the Court of Appeal decision in Jobson confirms that I have. In the light of my conclusions about Clause 5.1 standing on its own, it is clear to me that it would be quite inappropriate for me simply to strike it down and leave Cavendish to recover damages for its loss occasioned by breach of Clause 11.2, because it is clear that such loss would be largely irrecoverable. I did canvass with the parties during the course of the hearing the possibility of only enforcing Clause 5.1 in part, i.e, bearing in mind the guidance of Dillon and Nichols LJJ, not rewriting the clause but only enforcing it in part, by the use of a straightforward blue pencil, so as to delete reference to either the Interim Payment or the Final Payment. That, however, seems to me to be far too broad-brush and not to follow in any way from the nub of my conclusion, that it is the recovery of the loss by the Company which causes Clause 5.1 to be a penalty, and I would in any event be unable to determine which of the two payments to restore and why.

In the circumstances it is quite clear to me that the result of my conclusions is that, since it is only the recovery by the Company which renders Clause 5.1 a penalty, I should, given my inability to re-write the contract so as to include such a clause as discussed in paragraph 61 above, invite the Claimant to agree, if it wishes, to give credit for the $500,000, so that it can enforce Clause 5.1. I give Cavendish, as did the Court of Appeal in Jobson, the opportunity to agree to repay the $500,000 as a term of my making a declaration that the Claimant is not liable to make payment under Clause 3 of the agreement by virtue of Clause 5.1 and ordering specific performance of Clause 5.6. The $500,000 should be added to the price given for payment of the shares, upon transfer of them.

There remains one issue, raised very belatedly by the Defendant in his very recent Reamended Defence and Counterclaim, as to the construction of Clause 5.6, which I set out in paragraph 9(iii) above.

I have set out paragraphs 5.6 and paragraphs 5.7 in paragraph 7(iii) above. Mr Bloch’s submission is that Cavendish must tender the correct or true Defaulting Shareholder Option Price (“DSOP”) before the Defendant is obliged to sell or transfer his shares. It has become clear in the course of Mr Bloch’s oral submissions that the suggestion is not that Cavendish can never obtain the shares or exercise its option, but that it must serve a fresh notice, only once the correct price has been ascertained: the motive being explained to be that the Defendant has thus in the interim not been obliged to sell or transfer the shares, and thus has remained entitled to any dividends in the meanwhile. Cavendish’s case is that the notice was valid and effective, and if the Defendant has not transferred the shares until the price is calculated, he in any event held the shares on trust for Cavendish and had no right to any dividends.

There is no provision in clause 5.6 such as would support the Defendant’s case that Cavendish must specify the correct price in the notice: all that is required is a notice exercising such option. Mr Bloch relies upon the fact that the clause says that “the purchaser…shall buy and...seller shall sell...in consideration for the payment…of the” DSOP: relying on the words “in consideration”, he submits that there is no obligation to sell, and the obligation to transfer does not arise, until the consideration is paid.

The proposition is in my judgment unarguable:

Accordingly, subject to the response of Cavendish to paragraphs 62 and 63 above, I am prepared to make the declaration sought, and in principle to order specific performance in relation to the Defendant’s obligations under Clause 5.6, although the price cannot be finally calculated until resolution of the outstanding issue with regard to the date of default.