Liquidated damages – A recent win for contractual freedom

The UK Supreme Court recently (in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67 – the "Cavendish Judgment") formulated a new test for determining if a clause specifying agreed compensation for breach is an enforceable liquidated damages clause or an unenforceable penalty clause.

In broad terms, the Cavendish Judgment endorses the principle of freedom of contract, giving contracting parties greater scope to make their own bargains in relation to agreed compensation for breaches of English law contracts.  The principles set out in the Cavendish Judgment apply both to business-to-business and business-to-consumer agreements and represents a broadening of existing English law principle.

Given that English law judgments are often persuasive to Hong Kong courts, the Cavendish Judgment gives reason to consider the current position of liquidated damages and penalties, and how it may influence future decisions on such issues, under Hong Kong contract law and how the Cavendish Judgment may influence future decisions on these issues.  Liquidated damages clauses are fairly common under Hong Kong law contracts, so the shift in English jurisprudence is an important one for Hong Kong.

In summary, we believe that Hong Kong courts have historically favoured freedom of contract and so the Cavendish Judgment is likely to resonate with judicial views here. Liquidated damages clauses are a useful commercial tool for parties seeking to put a clear scope around contracting risks and pave the way for quicker dispute resolution should difficulties arise in the course of performance.

While the Cavendish Judgment offers some promise of a reduced role for judicial review or "second guessing" by courts of bargains struck by contracting parties, there is still a need to take care in drafting liquidated damages clauses to maximise their enforceability.  We make some recommendations below from a drafting perspective.

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