Penalties in English law

Penalties in English law are contractual terms which are not enforceable in the courts because of their penal character. Since at least 1720 it has been accepted as a matter of English contract law that if a provision in a contract constitutes a penalty, then that provision is unenforceable by the parties. However, the test for what constitutes a penalty has evolved over time. The Supreme Court most recently restated the law in relation to contractual penalties in the co-joined appeals of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis.

The law relating to contractual penalties in England has been entirely developed by judges at common law without general statutory intervention. The Supreme Court has noted that "[t]he penalty rule in England is an ancient, haphazardly constructed edifice which has not weathered well".

However, in addition to the common law rules relating to penalties, there are statutes which make express provision for avoidance of onerous clauses, such as the Unfair Contract Terms Act 1977 and the Unfair Terms in Consumer Contracts Regulations 1999.

The origin of the common law rules relating to penalties is often taken to be the decision of the House of Lords in the Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd decision in 1914. But the jurisdiction is actually much older. The oldest reported case relating to penalties appears to date from 1720, but even that case is decided on the basis that penalties were already generally considered unenforceable.

In their decision in Makdessi the Supreme Court reviewed the historical origins of the rule against penalty clauses in contracts. The law originated in the fifteenth century in relation to "defeasible bonds" (sometimes called penal bonds) which were a contractual promise to pay money, which might be discharged if certain obligations were performed (and if the obligations were not performed, then the payment terms under the bond could be enforced). However the courts of equity regarded these as what they really were - security for performance of the underlying obligation - and were prepared to restrain enforcement of such bonds where the defaulting party paid any damages due at common law. In time the courts of common law began to mirror this approach and stay any proceedings on such bonds where the defendant gave an undertaking to pay damages together with interest and costs. The position of the common law courts was adopted and codified in the Administration of Justice Act 1696 and later the Administration of Justice Act 1705. Accordingly, procedurally relief in relation to such bonds was thereafter administered entirely by the common law courts without intervention by the courts of equity. However, the courts of equity began to develop concurrent remedies for relief from forfeiture. With the decline of the use of defeasible bonds the procedural mechanics became increasingly applied to liquidated damages clauses.

...
Wikipedia