We reported on the cases of ParkingEye Ltd v Beavis and Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67  in our November newsletter on the same day the judgment was handed down by the Supreme Court. You may recall, this was a landmark ruling which updated the test to determine whether a penalty clause was unenforceable. In an unusual step, one aspect of that judgment has now been amended by Lord Clarke, making a change to his part of the court’s ruling.

The change related to whether certain clauses in the El Makdessi case should be viewed as primary or secondary obligations. While it does not impact the key features of the ruling about penalty clauses, it does highlight the critical distinction between primary and secondary obligations when considering whether a clause is, in fact, a penalty.

A secondary obligation is usually triggered by the breach of a primary obligation under a contract. For example, if I contract to clean your offices to a certain standard each week that is my primary obligation.  If I also agree that failing to clean to the required standard will result in me having to repay you 50% of my cleaning fee then that obligation to make repayment is a secondary obligation triggered only by my breach of the primary obligation to clean effectively.  If, however, the contract allowed me to choose whether or not I came and cleaned your offices each week but stated that on any weeks I did not attend then I would pay you a failure fee of £1,000, then that obligation to pay the failure fee would be my primary obligation.  It would be considered to be a conditional obligation because it would only become payable on my non-attendance.

The reason this distinction is important is because if the contractual obligation to make a payment (even one that might seem disproportionate and penalistic) is a primary obligation, then the whole penalty clause doctrine will not apply to it and it will be enforceable irrespective of how large or out of proportion the payment might seem. This was a feature of the Makdessi case where the contract was held not to impose an obligation to perform a particular act, but simply provided that, if one party did not perform the act, it would pay a specified sum to the innocent party. This was considered to be a conditional primary obligation and was characterised by the Supreme Court as a price adjustment clause.

The practical implications of this for businesses come down to the clarity of drafting in contractual terms – whether these are standard terms of business or bespoke contracts. It’s an area where precise and unambiguous drafting is necessary to ensure either that a payment provision is clearly a primary obligation or, if it is triggered by breach by the other party (and, therefore a secondary contractual obligation) that it does not fall foul of the recently updated rule against penalties.