Liquidated damages or penalty: the legitimate interest test (Cavendish v Makdessi)
Vantage Software Ltd agreed to install a booking system for Coastal Ferries Ltd by 1 March 2026. Clause 9 provides that if installation is late, Vantage will pay Coastal £50,000 for each day of delay. Both companies took legal advice. Coastal's realistic loss from delay is at most about £2,000 a day, and Coastal has identified no other commercial interest that the clause protects. Installation was completed ten days late, and Coastal claims £500,000 under clause 9.
Which of the following best describes whether clause 9 is enforceable?
Choose one answer to see the reasoning.
Worked answer
Correct answer A: It is unenforceable as a penalty, being out of all proportion to Coastal's legitimate interest in timely installation, so Coastal may claim its proven loss.
THE RULE TO REMEMBER
A clause triggered by breach is a penalty if it imposes a detriment out of all proportion to the innocent party's legitimate interest in performance; a penalty is unenforceable and ordinary damages apply.
Liquidated damages or penalty: the legitimate interest test (Cavendish v Makdessi)
In Cavendish Square Holding BV v Makdessi the Supreme Court restated the penalty rule. The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party has no proper interest in simply punishing the defaulter. In a straightforward damages clause, that interest will rarely extend beyond compensation for the breach. Clause 9 is triggered by breach of the obligation to install on time, so it is a secondary obligation. It requires £50,000 a day against a realistic loss of about £2,000 a day, and Coastal has identified no other legitimate interest. It is therefore a penalty and unenforceable. Coastal must instead prove and recover its actual loss as damages.
Why B is wrong: Legal advice and equal bargaining power are relevant, but they do not save a clause that is out of all proportion to any legitimate interest.
Why C is wrong: A penalty clause is unenforceable; the court does not rewrite it to a reasonable sum, and the claimant recovers its proven damages instead.
Why D is wrong: Labels are not decisive; the court looks at the substance and effect of the clause, not what the parties call it.
Why E is wrong: Clause 9 operates only on breach of the obligation to install on time, so it is a secondary obligation to which the penalty rule applies.
A little more practice done.
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