Will a clause in your settlement agreement amount to a penalty?
Published on 8th Apr 2021
The law on penalties was clarified by the Supreme Court in Cavendish Square v Makdessi (2015) as follows: is the detriment imposed following a breach "unconscionable, exorbitant, extravagant or out of all proportion" to the legitimate business interest which is being protected? A recent case is a useful reminder that the law on penalties applies to settlement agreements, as with any other type of agreement, and gives pointers as to when a clause might amount to a penalty.
In Permavent Ltd v Makin, the parties' settlement agreement provided (broadly) that the defendant would be paid certain amounts for his intellectual property rights (which were assigned to the claimant). However, if the defendant subsequently legally challenged the validity of those rights, the agreement provided that he would have to repay all sums and would receive no further payment. Was that, in effect, an unenforceable penalty?
The court found not. The judge said that the defendant believed he had been wronged and had a "volatile character" which gave rise to a reasonable inference, at the date of the settlement, that he would challenge the rights and make life as difficult as possible for the claimant. Although the detriment imposed was "undoubtedly extremely harsh" (running, potentially to several hundred thousand pounds and leaving the defendant with no consideration at all), it was not out of proportion because of the likely impact on the claimant's business if a challenge was brought.