Client Alert: English Contract Law Update: What Exactly Is a Penalty Clause?

Ever had to hesitate for thought when explaining to your business clients or a counterpart exactly what constitutes a penalty clause under English contract law?  Probably the biggest area of debate has been around whether the typical JOA default forfeiture provision constitutes a contractual penalty.  There are many other areas in oil and gas transactions where the subject is relevant however – an option for liquidated damages is included in the model form AIPN JOA for breach of the Transfer provisions, and increasingly this form of remedy is being used in Farmout Agreements, AMIs, and financing arrangements (for example, the common use of higher interest rates in periods of default).

Fortunately the UK Supreme Court has recently had the opportunity to review the rule on penalties in the conjoined cases Cavendish Square Holding BV v. Talal El Makdessi and ParkingEye Limited v. Beavis [2015] EWSC 67.  The Law Lords comment on the fact that over the past century or so the courts have struggled to formulate predictable principles for the doctrine.  Their judgments provide a welcome opportunity to assimilate and rationalise the significant body of case law.