Penalty Clause: Even if Penalty is harsh and damaging, it needs to be proportionate and therefore enforceable

 Penalty clause VAR: “extremely harsh” but still enforceable

11 March 2021 - Post by:Danielle Tullett

The court in Permavent v Makin determined that although the provision before it was “extremely harsh” it was not “out of all proportion” to the claimants’ legitimate business interests and so was not an unenforceable penalty.

Makin and Yeremeyev had operated a business which supplied roofing products to the construction industry through several companies, including Permavent and Greenhill. Makin invented roofing products under the name “Easy Roof System”, a number of which he successfully patented.

Following the breakdown of the relationship between the business partners, Makin left the business and terminated the patent licenses to Permavent. Permavent brought initial proceedings against Makin claiming that it was the owner of the relevant patents and a settlement agreement was reached. Under the settlement agreement Makin would receive a number of payments in exchange for which he agreed not to claim an interest in any of the intellectual property rights which had been assigned to Greenhill. Makin subsequently breached this agreement and Permavent sought to invoke the alleged penalty clause under the settlement agreement.

Per Cavendish v Makdessi, a penalty for breach of a party’s primary obligation becomes unenforceable should it be “unconscionable”, “extravagant” and/or “exorbitant” in relation to the legitimate business interests of the party who has suffered the loss or damage. The court concluded that although the detriment was harsh and damaging it was proportionate and therefore enforceable against Makin.

Some of the key factors the court considered were as follows:

1. Makin’s aggressive and abusive behaviour prior to entering into the settlement agreement;
2. the quantum of the claimants’ anticipated loss compared to the quantum of the penalty;
3. the fact Makin entered into the settlement agreement having obtained legal advice; and
4. the purpose of the relevant clauses in seeking to protect against the damage to the business of the claimants more widely, and not just to the value of the IP rights.

Ref. http://www.aocompactcontract.com/penalty-clause-var-extremely-harsh-but-still-enforceable/