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Contractor must lead evidence to prove that a clause is a penalty

8 Aug 11 It was for the contractors challenging a clause which they claimed was a penalty to prove that it was not a genuine pre-estimate of damages.

The claimants, the Hill family, proposed a development on a nearby site. In order to facilitate the development of the Morningside site, SMG and Bett were to install a sewage system and connect it to the mains for their own development. The Hills were to be entitled to connect to this at no cost and it would also service the Hill development. A similar arrangement was made for the surface/ storm water system. The parties’ Minute of Agreement said that that SMG and Bett were to use all reasonable endeavours to ensure completion and commissioning of the system by the Longstop Date. The works were not completed in time, and the Hills tried to claim the £5,000 per month it was entitled to under the agreement until the systems were commissioned and completed. SMG and Bett said that this damages provision was a penalty and, as such, unenforceable. The court at first instance ruled that the clause was potentially unenforceable, but it had been for the Hills to show that it was a genuine pre-estimate of loss and/ or damage. As they had not been able to show that, but for the failure to complete the system by the Longstop Date, they would have been able to sell their site and realise the return contemplated, they could not succeed. The Hills appealed.

SMG and Bett argued that that the relevant obligation imposed by the Minute of Agreement was to “use all reasonable endeavours” to ensure completion and commissioning of the system by the Longstop Date and that this was a quite different obligation from one to ensure completion and commissioning by the Longstop Date. The Hills said that it was conceivable that SMG and Bett might not achieve completion by the relevant date and yet, because they had used all reasonable endeavours they would not be in breach of contract. Payment depended on the Longstop Date being reached without completion of the system irrespective of whether the defenders were in breach. They argued that there was no mention of breach of contract in the pleadings, and that this was more an action for payment based on the non-occurrence of a specified event. Since the obligation to pay did not depend on a breach of contract, taking into account the rules summarised by Lord Macfadyen in City Inn Ltd. v Shepherd Construction Ltd., [2010] CSIH 68, there could be no question of it being an unenforceable penalty.

SMG’s and Bett’s response was that properly construed, their obligation had been to complete by the Longstop Date and that failure to do so was a breach of those obligations. This obligation was qualified so that they had only been obliged to use reasonable endeavours.

The court disagreed with the Sheriff Principal that the present clause was indistinguishable from that discussed in City Inn. He had erred in approaching the matter on the basis that the question was whether the pursuers had made sufficient relevant and specific averments to enable them to lead evidence to demonstrate that the provision was a genuine pre-estimate of damage. Whilst it had been open to the Hills to attempt to do this by way of answering the SMG’s and Bett’s claims that the provision was an unenforceable penalty, that did not alter the fact that the onus lay on the contractors. Accordingly, the primary question was whether the SMG and Bett had made sufficient specific pleadings to support their argument. The court found that their pleadings were no more than an assertion that the provision constituted a penalty and, as such, was unenforceable. There was nothing else which would allow them to lead evidence to show why this might be the case.

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In assessing whether a payment provision was exorbitant or unconscionable, the court should look at the position as at the date of the contract, and not the date of the breach, since at the conclusion of the contract, the parties had a wide discretion in fixing the amount of pre-estimated damages. The court should consider whether the sum to be levied was extravagant and unconscionable compared with the greatest loss which could follow from the breach. Stipulating for pre-estimated damages was recognised as a useful means of allowing the need for proof of a loss caused by breach and the party founding on such provision did not need to prove such loss. The Sheriff Principal had erred in not appreciating this. Having held that the Hills had averred sufficient to enable them to lead evidence as to the genuineness of their pre-estimate of loss in the event of breach, he went on to hold that their case was irrelevant because their pleadings revealed that the reason for the projected sale of the site was not because of the delay in completing the system but had been due to the decline in the housing market. He had not been entitled to do that.

It had been for SMG and Bett who were claiming that the clause was a penalty clause to give evidence to support their argument, and they had failed to do this. This was the critical question. From his judgment, it appeared that the Sheriff Principal had considered that it had been for the Hills not only to establish that the provision was a genuine pre-estimate of damages but that the supposed breach of contract had given rise to a loss of the sort that the pre-estimate had been intended to quantify. There had been no such requirement.

Hill v Stewart Milne Group and Gladedale (Northern) Ltd. (Formerly Bett Ltd.), [2011] CSIH 50

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