Let penalty clause rulings "bed in", Faculty urges

The law on penalty clauses in contracts should remain unchanged while a recent Supreme Court judgment is given time to “bed in”, according to the Faculty of Advocates.

Faculty was responding to a discussion paper of the Scottish Law Commission, which is examining the subject as part of its review of contract law.

The Commission's paper put forward three alternatives: leaving the law to develop in light of the court's decision in the Cavendish and ParkingEye appeals in 2015, abolishing the present common law on penalty clauses altogether, and abolishing the present common law against penalties and replacing it with a new regime.

Under the common law, parties to a contract can fix their own regime of damages for breach of contract only if the relevant term constitutes a genuine pre-estimate of the loss likely to be suffered. Anything else is regarded as an unenforceable penalty. However this distinction has been criticised as out of line with commercial reality, and the Supreme Court attempted to revise what it described as the "haphazardly constructed" rule to recognise that parties might have other interests to protect by way of a penalty clause.

Faculty takes the view that the decision in Cavendish/ParkingEye should be allowed to “bed in” with the further development of the law being kept under review, but no specific law reform being recommended at this point.

“As the discussion paper notes, Lord Hodge’s judgment addressed Scots Law directly… he was persuaded that the rule against penalties should remain part of the law of Scotland… he referred specifically to the fact that the Scottish Law Commission itself had in 1999 recommended the retention of judicial control over penalties”, its response states.

“The Faculty’s view is that specific law reform is not recommended at this time but rather that developments in the law, post-Cavendish, ought to be kept under active review for a reasonable period of time.”

It adds that if the common law rule were to be abolished, the “most careful and robust” consideration would require to be given to any draft legislation.

“The legislature would be interfering with a valid and enforceable contract and limiting the ability of parties to enter into bargains on terms they see fit.” 

Click here to view the full response.