Contract Law

Cavendish Square Holding BV v. Makdessi

[2015] UKSC 67

Facts

Makdessi sold a controlling interest in a large advertising and communications business to Cavendish.
The agreement contained restrictive covenants preventing him from competing with or damaging the business.
If he breached them:
he would lose entitlement to substantial deferred payments;
Cavendish could purchase his remaining shares at a price excluding goodwill value.
Makdessi breached the restrictive covenants.
He argued that these consequences were unenforceable penalties because they greatly exceeded any readily measurable loss.

The penalty rule applies only to a secondary obligation triggered by breach.
The question is whether the provision imposes a detriment out of all proportion to the innocent party’s legitimate interest in enforcing the primary obligation.
Compensation is not the only legitimate interest.
A party may legitimately protect:
goodwill;
business integrity;
confidential relationships;
commercial structure.
A clause negotiated between sophisticated parties with legal advice receives substantial respect.

The commercial value of the acquired business depended heavily on goodwill and client relationships.
Makdessi’s continued loyalty was therefore central to the transaction.
His competitive conduct could undermine value in a manner difficult to quantify through ordinary damages.
The deferred consideration was linked to the goodwill he had promised to preserve.
Removing goodwill value from the share-purchase calculation was commercially connected to his breach.
The clauses were negotiated by sophisticated parties.
They were not arbitrary sums inserted merely to punish.
Their purpose was to protect the very asset Cavendish had purchased.
The Court therefore rejected the older view that every clause exceeding a pre-estimate of loss is penal.
The broader inquiry is proportionality to a legitimate interest.

The clauses were upheld and were not penalties.
Use this case for: the modern penalty test asks whether the detriment is disproportionate to the innocent party’s legitimate interest.