An important decision of the Supreme Court has made it less likely that spurious challenges to asset financiers’ liquidated damages clauses will succeed.
For many years now there have been numerous challenges to liquidated damages clauses based on the common law rule against penalties, which in essence has been understood to provide that in order to be effective a liquidated damages clause must only provide for a genuine pre-estimate of the financier’s loss – otherwise it will be struck down as a “penalty” on the grounds of public policy.
Financiers have been careful to avoid a damaging precedent being set in a reported decision of the higher courts, but almost all asset financiers will have experience of being met with resistance to liquidated damages clauses on these grounds.
This area of law was ripe for review by the highest court, so a panel of seven judges sat in the combined appeals of Cavendish Square Holding BV v Makdessi and ParkingEye Ltd v Beavis (Consumers’ Association intervening) [2015] 3 W.L.R. 1373.
Unfortunately the judgments in these cases are rather complex, running to over 100 pages in total. Neither case involved asset finance but the principles to be derived are the same. The first case involved a complex series of investment agreements between sophisticated parties, whilst the second case involved the rather more mundane situation of a motorist overstaying the two hours allotted as free parking in a supermarket car park. However, both cases involved the court giving detailed consideration to the principles of liquidated damages and the concept of penalties.
The leading judgment was given by Lord Neuberger of Abbotsbury PSC and Lord Sumption JSC (with whom Lord Carnwath JSC agreed), who said at paras 31-32: –
“The real question when a contractual provision is challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss. These are not natural opposites or mutually exclusive categories. A damages clause may be neither or both. The fact that the clause is not a pre-estimate of loss does not therefore, at any rate without more, mean that it is penal. To describe it as a deterrent (or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent provision in a contract is simply one species of provision designed to influence the conduct of the party potentially affected. It is no different in this respect from a contractual inducement. Neither is it inherently penal or contrary to the policy of the law. The question whether it is enforceable should depend on whether the means by which the contracting party’s conduct is to be influenced are “unconscionable” or (which will usually amount to the same thing) “extravagant” by reference to some norm.
The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance”.
Lord Mance JSC said something similar at para 152:-
“What is necessary in each case is to consider, first, whether any (and if so what) legitimate business interest is served and protected by the clause, and, second, whether, assuming such an interest to exist, the provision made for the interest is nevertheless in the circumstances extravagant, exorbitant or unconscionable.”
Comment
As a result of this decision standard liquidated damages clauses used throughout the asset finance industry will be more difficult to challenge as penalties. It will normally be possible for the financier to demonstrate that such clauses are commercially justifiable in the context of its legitimate interest in holding customers to their contractual obligations to make payments throughout the life of an agreement.
However, care should still be taken to ensure that as far as possible liquidated damages clauses properly reflect the losses likely to be sustained by a financier upon termination in the event of default, and particular regard should be had to the relevance of the value of repossessed equipment which may well differ in the case of a finance lease, an operating lease and a hire purchase agreement.
The consequences of using unregulated paper for an agreement which is as a matter of law regulated by the Consumer Credit Act 1974 (“CCA”) are well-known throughout the industry. As originally drafted the CCA rendered such agreements irredeemably unenforceable, though a significant amendment effective as from 2006 provides that in general most such agreements will be enforced by the court in the absence of prejudice to the customer.
What of the opposite scenario: as a matter of law the agreement is not regulated by the CCA, but the financier uses paper which states that it is?
We are concerned here not with dual purpose documents, which have long been in widespread use in the asset finance industry particularly in the business to business sector, and which contain an express carve out for the situation where the customer is not regulated by the CCA or where the agreement is for business use above the £25K limit. The situation we are addressing is where there is no such “dual purpose” exemption clause, but rather the financier simply uses regulated paper by mistake in an unregulated situation.
The point arose squarely for decision in the recent decision of the Court of Appeal in NRAM plc v McAdam [2015] EWCA Civ 751. This case involved a loan agreement which was outside the CCA limits which then applied, but in relation to which the financier had used regulated paper. The effect was that if CCA s77A applied, no interest was recoverable during a lengthy period of non-compliance with the provision of the required post-contractual statements, and in the case of this financier some 41,000 agreements were affected with a sum of approximately £285 Million in play.
The case was brought on as a test case before the Commercial Court, and at first instance Burton J ruled against the financier on the basis that it must take the consequences of having used regulated paper. For a number of reasons and on different bases of legal analysis, the judge was clear that the customer was entitled to all the protections and remedies afforded to him by the CCA, despite the fact that as a matter of law the agreement was not within the jurisdiction of the CCA.
The financier appealed to the Court of Appeal.
The agreement contained express statements as to the right of cancellation and the right of early settlement as thought to be required by the relevant CCA Regulations, and the court had little difficulty in finding that these express statements on the face of the agreement amounted to express contractual terms binding on the parties.
However, the Court of Appeal disagreed with the judge on all the remaining issues. Firstly, the Court ruled that just as it was not open to the parties to contract out of the application of the CCA, so it was not open to the parties to contract into the CCA either: –
“In the light of the highly technical provisions of the 1974 Act, including particularly the role of the court in enforcing regulated agreements, we agree with Mr Waters’ submission that it would require very clear words before one could conclude that the parties agreed to give the court power to enforce the agreements in the limited circumstances given by the 1974 Act and in no other circumstances. It would be very unusual to give a court a discretionary power to enforce an agreement and still more unusual to import mandatory requirements such as those imposed on the court by (among other sections) section 127 which are peculiarly inapt to be imposed by agreement, as are the powers to make time orders, to impose conditions or to suspend the operation of an order as provided for by sections 129 and 135. This must all the more be the case when the parties would be uncertain whether a judge of the County Court would even accept he had jurisdiction to make any necessary order in the first place”.
Secondly, it was wrong to construe the wording on the regulated paper referring to the CCA as an agreement between the parties that the CCA would apply: –
“There is no factual matrix that supports the judge’s approach that the representation should be construed as an agreement on the part of the parties that, irrespective of whether the agreement was in fact regulated, the parties agreed that the borrowers would be treated “as if” the agreement was regulated. The fact that the defendants in this case, and, as one might suppose, many borrowers in the other 41,000 cases, thought they had entered into regulated agreements which had the protection of the 1974 Act, or alternatively thought that, irrespective of whether their loan agreement was actually a regulated agreement, they none the less had the protections of the 1974 Act, is of itself no basis to justify the inclusion of the term found to exist by the judge”.
Thirdly, there was no ground for the operation of the doctrine of estoppel either: –
“For the reasons which we have already given above in relation to the issue of construction, similarly, in the estoppel context, the relevant statements are in our view simply not capable of being regarded as a shared assumption that, whether or not the agreement was a regulated agreement, it would be treated as if it were and as if, so far as possible, the defendants would have the protection and rights conferred by the relevant legislation in force from time to time. As we have already said, the terms of the relevant statements are wholly inconsistent with such an assumption”.
However, there is some solace for customers in the judgement in that the Court went on to say that a customer may still have a remedy against a financier where regulated paper is used in an unregulated agreement: –
“As we have already said in earlier passages in this judgment, in our view the relevant statements on any basis amounted to a representation by NRAM that the loan agreement was an agreement regulated by the 1974 Act and that the borrowers were entitled to the protections afforded by the Act to borrowers under such regulated agreements. That representation, as Mr Waters accepted, indeed had legal effect in the sense that, if, as was the case, it was false, the borrower would be entitled to sue for misrepresentation under the Misrepresentation Act 1967. Given the context and prominence of the relevant statements, we take the view that they are to be construed not merely as representations but also as contractual warranties and that the borrowers would have been entitled to sue for breach of contractual warranty”.
Comment
This is a welcome decision applying common sense principles to the convoluted issue of CCA regulation.
Although the agreement in question was made before the £25K limit for regulation was removed in 2006 for non-business transactions, an adverse decision would still have had significant consequences for the asset finance industry in relation to both past and future transactions.
A note of caution still applies in view of the Court’s remarks that statements about the applicability of the CCA amounted to contractual warranties. However, customers are likely to face a number of hurdles in bringing successful claims based on breaches of warranty: –
(1) It would normally be necessary for customers to establish reliance, which is likely to be difficult unless they can show they were aware of specific provisions of the CCA at the time of the agreement;
(2) it may well be difficult to prove loss and damage; and
(3) the limitation period of six years will run from the date of the making of the agreement.
Of course none of this applies to the dual purpose documents, which have always been widely used in the asset finance industry, particular for financiers dealing with business customers. It is difficult to foresee any customer bringing a successful argument based on the fact that it didn’t bother to read the clause exempting a dual purpose agreement from regulation by the CCA, and this Court of Appeal decision should be confirmation that the industry has nothing to fear from the use of dual purpose documentation.
Robin joined Bermans in December 2015 and became a Partner in the Corporate department in 2022.
He qualified as a solicitor in 2011 having trained in London.
Robin advises clients ranging from start-ups to large companies on a range of corporate matters including mergers and acquisitions, private equity and venture capital investments, reorganisations, joint ventures, incorporations and corporate governance issues. He also regularly advises on employee share and incentive schemes.
Robin was ranked by Experian Corpfin as first in the North West for deals worked on in 2013, 2014 and 2018 and also first in the UK in 2014.
Dave joined Bermans in 1984 and qualified as a solicitor in 1986 following his degree in law.
Dave is a partner in our Invoice Finance team and is highly experienced in all commercial aspects of invoice finance and asset based lending and known for his commercial and practical advice to clients.
Dave has always been and still is a bit of a fitness fanatic and runs most days before work, cycles at the weekend and is a regular high handicap golfer who never seems to improve that much but loves the game!
Dave has worked in invoice finance nearly all of his professional career providing sound commercial advice to all Bermans clients in the invoice finance and asset based lending field and is well respected for his commercial and down to earth approach when advising clients.
Phil Farrelly is head of Bermans insolvency team and serves on Bermans board.
He has a degree in law and qualified as a solicitor in 1986.
Phil is a familiar face on the North West legal scene and has extensive experience of acting for insolvency practitioners, ABL and other lenders and directors in all aspects of corporate insolvency.
Clients find Phil approachable and responsive and value his pragmatic down to earth advice.
Clients recommended him to Legal 500 for his ‘wide range of experience, clear and pragmatic advice and good value for money’ when acting for lenders, administrators, liquidators and corporate clients and described him as ‘practical, commercial and technically strong’.
Jonathan is an award winning, experienced dispute resolver. He works with clients to resolve complex disputes in the most cost effective and commercial way.
He qualified as a solicitor in 1990 following his degree in law.
Jonathan’s commercial recovery work for asset based lenders has added to the firms niche in this area of practice.
Jonathan has been recognised as a top lawyer by the Times as their “Lawyer of the Week” in September 2011, and Legal Business Magazine who highly commended him for “Lawyer of the Year” in 2012. Jonathan was the Liverpool Law Society’s “Solicitor of the Year” in 2013.
Jon is Bermans Managing Director and Head of Corporate, having joined Bermans as a Corporate Partner in January 2012.
Jon spends time across both of the Manchester and Liverpool offices, working closely with practice area leaders and the operations team to ensure our people and clients remain at the heart of everything Bermans do.
Clients include a variety of companies, many of whom are owner-managed SMEs but also larger corporates.He has worked with clients across a range of sectors but has particular expertise in the financial services, high growth technology, creative/media and healthcare (particularly ophthalmic) sectors.Jon’s knowledge and experience allows him to provide clients with clear direction through what can be quite complex processes.In 2021, Jon contributed a chapter to ‘ From the Factory Floor: We Build Tech Companies’ – a book written by Bermans clients https://thestartupfactory.tech/.The book aims to help entrepreneurs launch and build better and more successful tech businesses.Jon’s chapter focuses on the legal building blocks needed to establish good corporate governance which sets the framework for growth, investment and ultimately exit.
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Ian Munford is Head of Asset Finance and one of the most reputed lawyers in the country specialising in this business area.
After his degree in Law at Sheffield University, Ian joined Bermans in 1978 upon qualifying as a solicitor. He acted extensively in those early years for then market leaders such as Anglo Leasing, Woodchester LMS and Lombard Business Equipment and the knowledge gained formed the foundation for his specialisation in asset finance.
Ian and his team provide legal advice and assistance to funders, brokers and discounters ranging from Bank subsidiaries and multinational financiers to small businesses. Services provided include documentation, risk advice, dispute resolution and regulatory work. He prides himself on building strong client relationships based on first class service delivery provided in a pragmatic and personable manner.
Fergal heads up the Property and Construction team in Bermans Liverpool and Manchester offices.
He qualified as a solicitor in 1986 following his degree in law.
Fergal specialises in commercial property transactions and his clients include property developers, investors, fund managers, banks and bridging loan companies.
His clients value his pragmatic approach and willingness and ability to ensure their objectives are met and he is well known and respected in the Liverpool business community.
Fergal has been the Bermans finance partner since 2007 and is a founding member of the Bermans board.
Alex Chapman is a partner in our invoice finance team in Liverpool.
Alex has been at Bermans since 1994 following his law degree and qualification as a solicitor in 1988.
Alex specialises in the non-contentious aspects of invoice finance assisting his clients on security matters, drafting of bespoke documentation, reviewing contracts for quality of debt issues and assisting invoice financiers when they fund acquisitions and buy-outs.
Alex is recognised by his clients for making complex areas of law understandable and applying legal principles in a commercial manner to ensure the job gets done. He values client service as a top priority and understands the needs of his client’s businesses. Alex regularly lectures the industry on legal issues affecting the invoice finance market.
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