Long viewed sceptically by commercial lawyers as an unpredictable interference with freedom of contract, the penalty rule has grown over the past half millennia from its humble equitable beginnings into a broad common law principle.

As contractual arrangements grew increasingly complex, judges struggled to articulate a clear, principled approach, leading to the rule growing into a “haphazardly constructed edifice” in need of reform (to quote Lords Neuberger and Sumption).

This rationalisation came in 2015 with the UK Supreme Court’s (UKSC) decisions in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis. This article considers Makdessi, some of the cases that have followed it and the lessons for contractual drafters.

Makdessi and the UKSC

Mr Makdessi and a business partner sold 60 percent of the shares in a company to Cavendish in exchange for four staged payments. The initial two were for significant amounts, reflecting the goodwill in the business. The latter two were payable if the company’s profits exceeded a threshold. The agreement contained standard non-compete provisions and required Makdessi to dispose of his interest in a competitor. The parties agreed that if Mr Makdessi or his partner breached the covenants, Cavendish: (i) would not be required to make any additional payments (the ‘forfeiture clause’); and (ii) would be entitled to buy the defaulting party’s remaining shares at their net asset value, which excluded the value of the goodwill (the ‘call clause’). The agreement was negotiated over six months, with both sides represented.

Jan-Mar 2018 issue

Kirkland & Ellis International LLP