Penalty Clauses And Enforcement Issues

Flynn & Anor v Breccia [2018] IECA 273; Sheehan v Breccia & Ors [2018] IECA 286

In the recent linked decisions of Sheehan v Breccia and Flynn and Benray v Breccia the Court of Appeal upheld the High Court's finding that a surcharge interest provision in a loan agreement was a penalty clause. In doing so it followed the established caselaw on what constitutes a penalty clause in this jurisdiction.

Penalty Clauses

If a clause in a contract provides for the payment of a sum of money in the case of a breach of that contract, the courts may deem that clause to be a penalty clause. In Ireland the test is whether the amount payable is a genuine pre-estimate of the probable loss of the innocent party caused by the breach of the contract. If it is not, the clause is a penalty and is unenforceable.

In 2015 the Supreme Court in the UK departed from the traditional test in the case of Cavendish Square Holding BV v Talal El Makdessi. The court in that instance found that the test was whether the clause amounts to an additional secondary obligation which imposes a detriment on the party who is in breach, which is out of all proportion to any legitimate interest of the innocent party.

Factual Summary

The plaintiffs were shareholders in the Blackrock Clinic. They financed the purchase of their shares through loans from Anglo Irish Bank ("Anglo"). The plaintiffs gave security for the loans in the form of mortgages over their shares. When Anglo entered into liquidation, the plaintiffs' loans were put up for sale by the special liquidators of Anglo's successor, Irish Bank Resolution Corporation ("IBRC"). Breccia, another shareholder in the Blackrock Clinic, purchased the plaintiffs' loans (outbidding the plaintiffs who were attempting to buy back the loans). Breccia then demanded repayment. During the course of litigation between the parties before the High Court, a question arose as to whether Breccia was entitled to include default surcharge interest and costs of enforcement in the redemption figure.

Court of Appeal

The principal issues to be determined by the Court of Appeal in Sheehan and Flynn were as follows:

Did the application of default surcharge interest amount to a penalty clause? The court found that it did amount to a penalty as the surcharge rate of 4% over the facility interest rate was not a genuine estimate of Anglo's loss or damage upon a default by the plaintiffs in...